Proposed special tax on goods and services
Betting and gaming
In a series of blog articles on tobacco taxation, IPS has claimed that increasing tobacco taxation has undeniable health and tax benefits. At a time when public finances are tight, policy solutions such as tobacco taxation, which can be used to increase government revenues without jeopardizing economic growth, are essential. Such measures can support additional expenditure related to pandemics in the coming years.
However, no tax increases on cigarettes are foreseen in Sri Lanka's 2021 budget. Instead, a simplification of taxes on a variety of sinful and other goods is proposed. In particular, the 2021 budget proposes "to improve the efficiency of tax collection by introducing an online administered unified tax on goods and services (GST) instead of the various taxes and duties on goods and services that are levied on alcohol under several laws and institutions," Cigarettes, telecommunications, betting and games and vehicles ”.
Details of how such a complex proposal will be implemented across a number of industries are yet to be announced. This blog analyzes some of these issues related to cigarette tax proposals in the 2021 budget.
On the way to effective taxation
Basically, the step towards digitization and streamlining taxes is a step in the right direction. Effective tax administration is important to reduce illicit trafficking and tax underpayment, and it is commendable that the government is planning steps to improve tax collection practices. However, a uniform solution in which goods from different industries are grouped with very different mechanisms to achieve optimal tax revenues is counterproductive. For example, one type of tax that could optimize vehicle revenue collection will not necessarily do the same for cigarettes.
In the case of cigarettes, it is not clear whether the newly proposed GST will replace the main tax component for cigarettes, namely excise duty, and / or smaller tax components such as VAT, and whether it is a tiered tax system – with different tax rates depending on the length on cigarettes applied – are retained.
GST on cigarettes
While efforts to simplify and digitize taxes are laudable, it is a step backwards if the budget proposals are to replace the existing excise tax on cigarettes with a price-applied GST (as has traditionally been the case). Internationally, there is a strong trend going in the other direction – from sales taxes to excise taxes.
IPS research into cigarette tax reforms in Sri Lanka has shown that the existing specific excise duty system for cigarettes is in line with best practices set out in the WHO Framework Convention on Tobacco Control (FCTC), of which Sri Lanka is a signatory. 120 countries that have signed the WHO FCTC protocol have introduced excise duty systems on cigarettes, and Sri Lanka is one of them.
Specific excise duties are recommended for cigarettes, imposed on the volume of the product via ad valorem / sales taxes such as GST imposed as a percentage of the product price. This is because when the tax is applied to the price, the manufacturer has the incentive to lower cigarette prices and avoid taxes. Tobacco companies can lessen the impact of a tax hike by lowering the prices used to calculate tax liability. Price cuts to reduce tax liability should reduce government revenues and limit the impact of tobacco control.
Specific tax systems that charge cigarette tax by quantity rather than price are less susceptible to this type of manipulation of industry prices than those associated with ad valorem tax systems. Hence, moving to GST to reduce the loss of revenue from tax evasion and illicit trafficking is a contradicting goal.
Instead of deviating from a particular excise system, it would be more cautious to increase the existing excise duties on cigarettes in line with inflation. In addition, the efficiency of the collection of cigarette taxes can be improved by streamlining the existing five-tier tax structure for cigarettes to a single consumption tax. A unified tax structure ensures that all cigarettes are subject to tax increases, thus avoiding selective measures to keep taxes on cheaper cigarettes low.
This prevents the manufacturer from lowering prices in order to move certain products to a tier with a lower tax rate. If these proposals are implemented in 2020-2023, the government can increase tax revenue from cigarettes by Rs. 37 billion by 2023.
Therefore, the government should first streamline the complex tax structures in industries like tobacco before applying a single tax across industries that could streamline revenue collection for some, but not all, products. In addition, this should be combined with measures to improve the effectiveness of the tax administration system, for example through a strong and well-enforced track and trace system to reduce losses from tax evasion and illicit trafficking.
The author is a research fellow at the Institute for Political Studies in Sri Lanka with research interests in the areas of taxes, labor and migration, as well as econometrics and economic modeling. She holds a BSc in Economics from the University of London International Programs and a BA in Economics from the University of Colombo. She also has an MSc in Economics from the University of Warwick.